Altmann and Webb demand tax loophole is closed

Former pension ministers Baroness Altmann and Sir Steve Webb have called on the Chancellor of Exchequer to close a loophole which denies tax relief to low earners.

They have sent a letter to Philip Hammond urging the government to introduce a clause in the next Finance Bill to address this issue which, according to their calculations based on figures from HM Revenue & Customs (HMRC) from 2015/16 – could be affecting 1.22m people.

"To prevent auto-enrolment being undermined, it is essential that the government takes decisive action", the letter said.

Members of pension schemes who don't pay income tax are granted basic rate tax relief of 20 per cent on pension contributions up to £2,880 a year.

In practice this means HMRC will top up a net contribution of £2,880 to a gross £3,600.

But this tax relief is only available where the pension scheme operates on a relief-at-source basis, which is only accessible through a handful of companies.

It is not available for schemes that operate a net pay arrangement, which are the majority of pension funds in the market.

The difference between these two arrangements has become more noticeable since the income tax personal allowance increased to £11,850, which is above the auto-enrolment minimum threshold of £10,000.

Sir Steve, now director of policy at Royal London, said: "Having two different ways of delivering tax relief to workers has the perverse result that some low earners can miss out completely on tax relief depending on what sort of scheme their employer has chosen.

"It is unrealistic to expect employers to understand this distinction and unfair on low-paid workers who need the help more than anyone else.

"It is time for the government to stop talking about this issue but to fix it, so that low-paid workers get the benefit of tax relief, regardless of the pension arrangement their employer has chosen."

The signatories, which include representatives from unions, trade bodies, charities and pension providers, said HMRC is already looking at ways to solve an issue which has arisen with relief at source schemes as a result of different tax rates in Scotland and should use this opportunity to address the tax relief loophole.

Outside Scotland, tax relief is applied at one of three marginal rates – 20, 40 and 45 per cent – while Scottish workers have new rates – 19, 20 and 21 per cent - after the nation's government introduced new bands in April.

When a saver is enrolled in a relief at source scheme, he pays out of his post-tax income and the provider contacts HMRC on his behalf to claim basic rate relief at 20 per cent for everyone in the scheme.